The financial benefits of transitioning to a low-carbon economy are clear and significant, writes David Nelson, especially if policymakers act now.

David Nelson is senior director at the Climate Policy Initiative

Later this week, European Union leaders are due to agree on energy and climate targets for 2030. A meeting to set energy policy for the next fifteen years comes at an awkward moment, with energy prices in freefall – oil prices have fallen by a quarter since this summer – and European economies again on the verge of recession.

Politicians could be tempted to back away from the ambitious transition to a low-carbon economy as being too expensive for the fragile economy, especially in the light of lower fossil fuel prices. But they would be wrong, for new research shows that decisive and ambitious action to build a low carbon economy could lower energy costs even while providing a platform for continued economic growth. In fact, by reducing demand for fossil fuels, one important side effect of a low-carbon transition would to keep conventional energy prices low, which would be particularly beneficial to net energy importers such as the EU.

With the right policies, the financial benefits for the EU of a transition to a low-carbon economy are clear and significant. For instance, because the EU is a net consumer of oil, employing the right combination of pricing and innovation policies to transition to low-carbon transport could reduce both the quantity and price of the region’s fossil fuel imports. The result could be a net benefit to the financial system of more than US $1 trillion, increasing countries’ ability to invest in infrastructure and industries fit for the twenty first century.

For now, Europe as a whole has little to lose from a transition away from coal to low-carbon power. Existing regulations and retiring coal-fired plants at the end of their natural lives will put the EU largely on track to achieve the savings in carbon emissions consistent with preventing dangerous climate change with little economic downside.

Good electricity market design could preserve the value of the remaining coal plants by paying them to provide flexible generation to balance out renewable energy. In this case, the total value at risk of losing economic value or “stranding” is less than 2% of EU power plant investments in 2011 alone. However, any further investment in new coal-fired plants or in extending the life of existing plants would increase the risk that value would be lost when coal capacity needs to be closed early to meet emissions targets.

Clear policy signals can set the tone for investment. Private investors in the low-carbon energy system need clear, long-term policy signals that help to reduce risk perception. Previous targets have helped Europe to increase its energy security, build a leading position in low-carbon goods and services, and become more productive in its use of carbon.

Last month over 300 institutional investors from around the world representing over $24 trillion in assets, called on government leaders to phase out fossil fuel subsidies and implement the kind of carbon pricing policy that will enable them to redirect trillions to investments compatible with fighting climate change.

Low-carbon energy costs continue to fall. Financial innovation can drive them down further and help save electricity consumers billions. Innovation has driven down the price of renewable technologies dramatically. If this is matched by innovation in finance and business models then the low-carbon energy transition will go from the margins of an energy system built around the strengths of fossil fuels to one with low-carbon power at its centre. New financial instruments better suited to investors’ needs can reduce the cost of renewable energy by up to 20%.